Deck 8: Risk and Return

Question 1

For the risk-averse manager, the required return decreases for an increase in risk.

Answer 1

False

Question 2

The ________ of an asset is the change in value plus any cash distributions expressed as a percentage of the initial price or amount invested.

A) return
B) value
C) risk
D) probability

Answer 2

return

Question 3

Interest rate risk is the chance that changes in interest rates will adversely affect the value of an investment; most investments decline in value when the interest rates rise and increase in value when interest rates fall.

Answer 3

True

Question 4

The return on an asset is the change in its value plus any cash distribution over a given period of time, expressed as a percentage of its ending value.

Question 5

For the risk-averse manager, required return would decrease for an increase in risk.

Question 6

If a person requires greater return when risk increases, that person is said to be

A) risk-seeking.
B) risk-indifferent.
C) risk-averse.
D) risk-aware.

Question 7

Most managers are risk-averse, since for a given increase in risk they require an increase in return.

Question 8

For the risk-seeking manager, no change in return would be required for an increase in risk.

Question 9

Interest rate risk is the chance that the value of an investment will decline because of market factors (such as economic, political, and social events) that are independent of the investment.

Question 10

Financial risk is the chance that the firm will be unable to cover its operating costs and is affected by a firm's revenue stability and the structure of its operating costs (fixed vs. variable).

Question 11

Business risk is the chance that the firm will be unable to cover its operating costs and is affected by a firm's revenue stability and the structure of its operating costs (fixed vs. variable).

Question 12

Investment A guarantees its holder $100 return. Investment B earns $0 or $200 with equal chances over the same period. Both investments have equal risk.

Question 13

If a person's required return does not change when risk increases, that person is said to be

A) risk-seeking.
B) risk-neutral.
C) risk-averse.
D) risk-aware.

Question 14

For the risk-indifferent manager, no change in return would be required for an increase in risk.

Question 15

Liquidity risk is the chance that changes in interest rates will adversely affect the value of an investment; most investments decline in value when the interest rates rise and increase in value when interest rates fall.

Question 16

Purchasing-power risk is the chance that changes in interest rates will adversely affect the value of an investment; most investments decline in value when the interest rates rise and increase in value when interest rates fall.

Question 17

If a person's required return decreases for an increase in risk, that person is said to be

A) risk-seeking.
B) risk-indifferent.
C) risk-averse.
D) risk-aware.

Question 18

Risk aversion is the behavior exhibited by managers who require a (n)

A) increase in return, for a given decrease in risk.
B) increase in return, for a given increase in risk.
C) decrease in return, for a given increase in risk.
D) decrease in return, for a given decrease in risk.

Question 19

________ is the chance of loss or the variability of returns associated with a given asset.

A) Return
B) Value
C) Risk
D) Probability

Question 20

Last year Mike bought 100 shares of Dallas Corporation common stock for $53 per share. During the year he received dividends of $1.45 per share. The stock is currently selling for $60 per share. What rate of return did Mike earn over the year?

A) 11.7 percent
B) 13.2 percent
C) 14.1 percent
D) 15.9 percent

Question 21

On average, during the past 75 years, the return on long-term government bonds has exceeded the return on long-term corporate bonds.

Question 22

On average, during the past 75 years, the return on small-company stocks has exceeded the return on large-company stocks.

Question 23

An approach for assessing risk that uses a number of possible return estimates to obtain a sense of the variability among outcomes is called sensitivity analysis.

Question 24

Asset A was purchased six months ago for $25,000 and has generated $1,500 cash flow during that period. What is the asset's rate of return if it can be sold for $26,750 today?

Question 25

The risk of an asset can be measured by its variance, which is found by subtracting the worst outcome from the best outcome.

Question 26

On average, during the past 75 years, the return on U.S. Treasury bills has exceeded the inflation rate.

Question 27

On average, during the past 75 years, the return on U.S. Treasury bills has exceeded the return on long-term government bonds.

Question 28

On average, during the past 75 years, the return on long-term corporate bonds has exceeded the return on long-term government bonds.

Question 29

Tim purchased a bounce house one year ago for $6,500. During the year it generated $4,000 in cash flow. If Time sells the bounce house today, he could receive $6,100 for it. What would be his rate of return under these conditions?

Question 30

A normal probability distribution is a symmetrical distribution whose shape resembles a bell-shaped curve.

Question 31

The more certain the return from an asset, the less variability and therefore the less risk.

Question 32

Coefficient of variation is a measure of relative dispersion used in comparing the expected returns of assets with differing risks.

Question 33

The larger the difference between an asset's worst outcome from its best outcome, the higher the risk of the asset.

Question 34

On average, during the past 75 years, the return on large-company stocks has exceeded the return on small-company stocks.

Question 35

Prime-grade commercial paper will most likely have a higher annual return than

A) a Treasury bill.
B) a preferred stock.
C) a common stock.
D) an investment-grade bond.

Question 36

On average, during the past 75 years, the inflation rate has exceeded the return on U.S. Treasury bills.

Question 37

On average, during the past 75 years, the return on large-company stocks has exceeded the return on long-term corporate bonds.

Question 38

The real utility of the coefficient of variation is in comparing assets that have equal expected returns.

Question 39

One measure of t he risk of an asset may be found by subtracting the worst outcome from the best outcome.

Question 40

Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for $30 per share. If Perry sells all of his shares of Ferro, Inc. today, what rate of return would he realize?

Question 41

A common approach of estimating the variability of returns involving forecasting the pessimistic, most likely, and optimistic returns associated with the asset is called

A) marginal analysis.
B) sensitivity analysis.
C) break-even analysis.
D) financial statement analysis.

Question 42

Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1, 2002. He received a dividend of $2.00 per share at the end of 2002 and $3.00 per share at the end of 2003. At the end of 2004, Nico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Nico's realized holding period return? What was Nico's compound annual rate of return?

A) -12.5%; -4.4%
B) +12.5%; +4.4%
C) -16.7%; -4.4%
D) +16.7%; +4.4%

Question 43

Since for a given increase in risk, most managers require an increase in return, they are

A) risk-seeking.
B) risk-indifferent.
C) risk-free.
D) risk-averse.

Question 44

The ________ of an event occurring is the percentage chance of a given outcome.

A) dispersion
B) standard deviation
C) probability
D) reliability

Question 45

The higher the coefficient of variation, the greater the risk and therefore the higher the expected return.

Question 46

________ probability distribution shows all possible outcomes and associated probabilities for a given event.

A) A discrete
B) An expected value
C) A bar chart
D) A continuous

Question 47

Given the following information about the two assets A and B, determine which asset is preferred.

Question 48

The expected value and the standard deviation of returns for asset A is (See below.) Asset A

A) 12 percent and 4 percent
B) 12.7 percent and 2.3 percent
C) 12.7 percent and 4 percent
D) 12 percent and 2.3 percent

Question 49

The ________ is a measure of relative dispersion used in comparing the risk of assets with differing expected returns.

A) coefficient of variation
B) chi square
C) mean
D) standard deviation

Question 50

The lower the coefficient of variation, the greater the risk and therefore the higher the expected return.

Question 51

The ________ the coefficient of variation, the ________ the risk.

A) lower; lower
B) higher; lower
C) lower; higher
D) more stable; higher

Question 52

Which asset would the risk-averse financial manager prefer? (See below.)

A) Asset A.
B) Asset B.
C) Asset C.
D) Asset D.

Question 53

The ________ is the extent of an asset's risk. It is found by subtracting the pessimistic outcome from the optimistic outcome.

A) return
B) standard deviation
C) probability distribution
D) range

Question 54

The expected value, standard deviation of returns, and coefficient of variation for asset A are (See below.) Asset A

A) 10 percent, 8 percent, and 1.25, respectively.
B) 9.33 percent, 8 percent, and 2.15, respectively.
C) 9.35 percent, 4.68 percent, and 2.00, respectively.
D) 9.35 percent, 2.76 percent, and 0.295, respectively.

Question 55

Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1, 2002. He received a dividend of $2.00 per share at the end of 2002 and $3.00 per share at the end of 2003. At the end of 2004, Nico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Nico's realized holding period return?

A) -12.5%
B) +12.5%
C) -16.7%
D) +16.7%

Question 56

A normal probability distribution is an asymmetrical distribution whose shape resembles a pyramid.

Question 57

An abnormal probability distribution is a symmetrical distribution whose shape resembles a bell-shaped curve.

Question 58

The ________ measures the dispersion around the expected value.

A) coefficient of variation
B) chi square
C) mean
D) standard deviation

Question 59

Given the following expected returns and standard deviations of assets B, M, Q, and D, which asset should the prudent financial manager select?

A) Asset B
B) Asset M
C) Asset Q
D) Asset D

Question 60

The coefficient of variation is a measure of relative dispersion that is useful in comparing the risks of assets with different expected returns.

Question 61

The standard deviation of a portfolio is a function of the standard deviations of the individual securities in the portfolio, the proportion of the portfolio invested in those securities, and the correlation between the returns of those securities.

Question 62

A collection of assets is called a(n)

A) grouping.
B) portfolio.
C) investment.
D) diversity.

Question 63

The goal of an efficient portfolio is to

A) maximize risk for a given level of return.
B) maximize risk in order to maximize profit.
C) minimize profit in order to minimize risk.
D) minimize risk for a given level of return.

Question 64

New investments must be considered in light of their impact on the risk and return of the portfolio of assets because the risk of any single proposed asset investment is not independent of other assets.

Question 65

Perfectly ________ correlated series move exactly together and have a correlation coefficient of ________, while perfectly ________ correlated series move exactly in opposite directions and have a correlation coefficient of ________.

A) negatively; -1; positively; +1
B) negatively; +1; positively; -1
C) positively; -1; negatively; +1
D) positively; +1; negatively; -1

Question 66

An investment advisor has recommended a $50,000 portfolio containing assets R, J, and K; $25,000 will be invested in asset R, with an expected annual return of 12 percent; $10,000 will be invested in asset J, with an expected annual return of 18 percent; and $15,000 will be invested in asset K, with an expected annual return of 8 percent. The expected annual return of this portfolio is

A) 12.67%.
B) 12.00%.
C) 10.00%.
D) unable to be determined from the information provided.

Question 67

Champion Breweries must choose between two asset purchases. The annual rate of return and related probabilities given below summarize the firm's analysis. For each asset, compute
(a) the expected rate of return.
(b) the standard deviation of the expected return.
(c) the coefficient of variation of the return.
(d) Which asset should Champion select?

Question 68

The ________ is a statistical measure of the relationship between series of numbers.

A) coefficient of variation
B) standard deviation
C) correlation
D) probability

Question 69

Assuming the following returns and corresponding probabilities for asset A, compute its standard deviation and coefficient of variation.

Question 70

A(n) ________ portfolio maximizes return for a given level of risk, or minimizes risk for a given level of return.

A) efficient
B) coefficient
C) continuous
D) risk-indifferent

Question 71

Given the following probability distribution for assets X and Y, compute the expected rate of return, variance, standard deviation, and coefficient of variation for the two assets. Which asset is a better investment?

Question 72

Combining negatively correlated assets having the same expected return results in a portfolio with ________ level of expected return and ________ level of risk.

A) a higher; a lower
B) the same; a higher
C) the same; a lower
D) a lower; a higher

Question 73

Two assets whose returns move in the opposite directions and have a correlation coefficient of -1 are both either risk-free assets or low-risk assets.

Question 74

The College Copy Shop is in process of purchasing a high-tech copier. In their search, they have gathered the following information about two possible copiers A and B. (a) Compute expected rate of return for each copier.
(b) Compute variance and standard deviation of rate of return for each copier.
(c) Which copier should they purchase?

Question 75

The financial manager's goal for the firm is to create a portfolio that maximizes return in order to maximize the value of the firm.

Question 76

An efficient portfolio is one that

A) maximizes risk for a given level of return.
B) maximizes return for a given level of risk.
C) minimizes return for a given level of risk.
D) maximizes return at all risk levels.

Question 77

Two assets whose returns move in the same direction and have a correlation coefficient of +1 are each very risky assets.

Question 78

Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1, 2002. He received a dividend of $2.00 per share at the end of 2002 and $3.00 per share at the end of 2003. At the end of 2004, Nico collected a dividend of $4.00 per share and sold his stock for $18.00 per share. What was Nico's realized holding period return? What was Nico's compound annual rate of return? Explain the difference?

Question 79

An efficient portfolio is a portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return.

Question 80

The standard deviation of a portfolio is a function only of the standard deviations of the individual securities in the portfolio and the proportion of the portfolio invested in those securities.